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Is the Fed a Private Bank or Public Institution?

Written By Geoffrey Pike

Posted January 8, 2016

ffeddThe Federal Reserve, commonly referred to as “the Fed”, states that its dual mandate is price stability and maximum employment. When the Fed refers to price stability, they actually want small price inflation. In fact, it is the central bank that makes inflation possible.

Many people think the Fed is a private bank disguised as a public institution. If anything, I think it is the opposite. The Fed has monopoly power over the money supply as granted by the federal government, along with other powers. The Fed chair is nominated by the president and approved by the Senate. The Federal Reserve Act of 1913 is what created and established the Fed.

There is no doubt that the Fed helps the big financial institutions, whether it is with loans and implicit guarantees, or outright bailouts as we saw in 2008. There is also no doubt that the Fed helps Congress and the entire federal government. The Fed enables Congress to run deficits at lower interest rates and spend money that otherwise would not likely be possible.

You could say there is something of an alliance between Congress, the Federal Reserve, and the big banks. But we can’t mistake this for capitalism or free markets. It is really cronyism at its worst.

That is why it is so surprising that there is a bit of finger pointing by some of the big financial institutions. Bank of America in particular recently came out with some surprising words.

As reported by Zero Hedge, Benjamin Bowler, from Bank of America’s Global Equity Derivatives Research, released a statement saying, “Essentially central banks, by unfairly inflating asset prices have compressed risk like a spring to unfairly tight levels. Unfortunately, the market is aware the price of risk is not correct, but they can’t fight it, and everyone is forced to crowd into the same trade. By manipulating markets they have also reduced investors’ inherent conviction by rendering fundamentals less relevant.”

That statement continues, “This then creates a highly unstable (fragile) situation that breaks violently when a sufficient catalyst causes risk to rise – overly crowded positioning meets a market with little conviction.”

I’m not sure what is most surprising here – the fact that Bank of America is questioning the wisdom of the Fed, or the fact that Bank of America is acknowledging the artificial business cycle.

Here we have one of the major banks in the country that is basically saying that the Fed is creating artificial bubbles and is essentially putting investors in a position of taking on risky positions.

Searching for Yield in Bubbles

To top off the comments from a Bank of America official, JP Morgan showed a chart stating, “Mission accomplished: QE drives up equity valuations”. Here is another financial institution alleging that the Fed’s loose monetary policies are driving bubble activity, particularly in stocks.

The Fed has had a policy of loose money and low interest rates since at least the fall of 2008. Market interest rates have stayed down too, much of it due to fear in the U.S. economy, which is a result of the major recession that was originally caused by loose money and low interest rates.

When interest rates are near zero and the Fed is expanding the monetary base (as it did up until October 2014), then investors get desperate for yield. They are essentially forced to take risks that they otherwise would not take.

If there is a crash in stocks – and the first trading day of the year indicated a possible rough 2016 ahead – then the Fed is going to take a lot of the blame. Unfortunately, the Keynesian media is going to blame the wrong aspect.

They are going to say that Janet Yellen and company raised interest rates too soon and that the Fed should have kept its key rate near zero. They are going to blame the Fed for being too “hawkish”, as if near-zero rates and three rounds of major quantitative easing (money creation) are somehow too hawkish.

Don’t get me wrong here; it will be the Fed’s fault. But the fault isn’t in raising the federal funds rate by a quarter of a percent. The fault isn’t in stopping the money creation.

It is the fault of the Fed for all of the previous actions of loose money and artificially low interest rates. As analysts at these major banks are now noting, it is the Fed that is responsible for blowing up the asset bubbles. If there is going to be a big pop, it is because it is already baked into the cake. Raising its key interest rate may speed things up a little, but it certainly is not the original cause.

The Fed is taking more criticism now than it has in its 100-year history. Most of the analysts on CNBC may not be attacking the Fed – or at least not for the right reasons – but it doesn’t mean that Fed officials aren’t feeling a little heat.

Now you can see some dissention, as even some of the big players are questioning the Fed’s previous decisions. If and when the bubbles pop, I suspect that these big players do not want to lose all credibility. You could say they are hedging their bets, even if it means questioning the institution that helps them stay in business.